If you could only run one procedure on a set of small business financials before buying the company, it should be proof of cash.
It is unglamorous. It is also the only procedure that tests whether the revenue on the income statement corresponds to money that arrived in a bank account, and everything else in a Quality of Earnings report is built on top of that answer being yes.
Proof of cash reconciles reported revenue to actual bank deposits, month by month, across every operating account, for the full period under review.
You start with total deposits. You strip out anything that is not revenue: loan proceeds, owner contributions, transfers between accounts, refunds, insurance settlements, the sale of an asset. What is left should approximate reported revenue, allowing for timing and for the difference between cash and accrual recognition.
When it does not, you have found something. What you have found is usually not fraud. But it is always worth understanding before you pay a multiple on the number.
Revenue that was recorded but never collected. A sale booked, an invoice issued, and nothing ever arrived. On accrual books this sits in receivables until someone writes it off. On a three-year lookback it can be a meaningful share of a year.
Transfers counted as revenue. Money moving between the owner's accounts, or from a related entity, recorded as income. Almost always a bookkeeping error rather than intent, and it inflates the number just the same.
Deposits with no corresponding revenue. Loan proceeds or an owner injection sitting in the revenue line, which flatters a year and is invisible from the profit and loss alone.
Undeposited cash revenue. The one buyers ask about most. Some owners will tell you, sometimes proudly, that reported revenue understates the business because a share of cash sales never hit the books.
On that last one, our position is simple and does not change: if it is not in the bank, it is not in the analysis. Not because we doubt the owner, but because it cannot be verified and it cannot be financed. A lender will not underwrite money that has no record, and a buyer paying a multiple on it is paying for a story.
A reasonable objection: if the books are on a cash basis, are they not already tied to cash?
Not really. Cash-basis books record what the bookkeeper entered as cash movement, which is not the same as what the bank shows. Deposits get categorized wrong. Accounts get missed. A merchant processor nets fees before depositing and the gross never appears anywhere. The books are one record of cash and the bank statement is another, and they disagree more often than people expect.
We have found differences between company books and bank statements that had already made it onto filed tax returns, on deals where the lender underwrote without anyone checking. That is the situation this procedure exists to prevent.
Two reasons, and neither is good.
It is laborious. Thirty-six months of statements across multiple accounts is real work, and it is the first thing to disappear when a provider is competing on price.
And historically, nobody insisted. Banks underwrote to a debt service coverage ratio calculated off financials the borrower supplied. Valuations took reported earnings as given. If nobody was checking whether the revenue was real, the procedure that checks it had no advocate.
SOP 50 10 8.1 changes that. A cash proof is among the procedures now expected on SBA acquisition deals over $3 million, and we think it is the most consequential part of the rule, more than the threshold or the question of who the client is.
A report can say proof of cash and mean anything from a full monthly reconciliation to a glance at the annual totals. Three questions separate them:
Run it on yourself first. It takes a bookkeeper a day or two, and finding the discrepancy yourself, with time to explain or correct it, is a completely different conversation from having a buyer's provider find it three weeks before closing.
Every unexplained gap between deposits and revenue is a discount a buyer will apply, and most of them turn out to have ordinary explanations. The cost of finding out early is small. The cost of finding out late is priced into your deal.